As the seasons change, many of us turn to our closets in an attempt to thin things out a bit, making room for new clothes or simply getting rid of items to reduce the clutter. If you’re like me, you run into at least one item you haven’t worn in several years, but you are afraid to get rid of it because what if that one scenario arises where it makes perfect sense to wear it? How likely will that ideal scenario present itself in the next few years? Why hasn’t it presented itself in the past? Why do we keep things with a very low probability of being used? Our behavioral biases may likely be coming to the forefront.
Understanding the Role Behavior in Financial Decisions
Behavior is a broad term that often represents how we approach or conduct ourselves in a situation. Some behavior we actively think about, and some behavior is at work behind the scenes in our subconscious. One area that has become ever more popular is the impact of our behavior throughout our financial lives with thoughts like, “That is a great company; it can only go up, so I am going to invest heavily in this one great company.”
In my personal life, I sometimes act against what my logical brain tells me is the right thing to do. I’ll find myself thinking, “I should go to sleep to get a full night’s rest, but … the kids are asleep, and I can finally watch my favorite show.” Working with clients in investing, I also notice that the best decision is sometimes the hardest to come to terms with in the moment, considering a variety of outside influences or environmental conditions. This intrigue led me to search for a deeper understanding to better help clients become aware of the various behavioral influences that may affect their financial decisions. Ultimately, it led me to obtain the Accredited Behavioral Financial Professional (ABFP™) designation.
ABFP™: Bridging Understanding and Action
ABFP™ is a rather new designation indicating that through the training provided by the program, an advisor is more likely to have enhanced emotional competencies, client interactions, and be able to deliver appropriate financial planning advice by developing a thorough understanding of psychological explanations for economic behavior and hands-on knowledge practice. Simply put, they’ve studied to understand why we act irrationally in the face of rational data or observations and know how to identify this behavior in the moment to help make sound decisions no matter what’s on our plates.
Why do we often act irrationally in the face of rational data? Because it’s hard. Naturally, as humans, we often seek the path of least resistance. Our minds are great at painting the situation we want to see (i.e., confirmation bias), usually because it’s less stressful and takes less mental effort. The ABFP™ has helped me identify situations where behavioral bias may cloud the full picture. It’s never an advisor’s role to tell clients what to do but rather to educate them about a given decision’s pros and cons.
Customized Financial Planning
As more structure and process are established, the behavioral side of financial planning has become better understood in terms of its impact on financial decision-making. Let’s look at an example: Choosing an allocation between stocks and bonds. Many of your friends or family members may take a specific approach to this decision. Is their approach right for you? When we talk about money, we all use our own filters and personal experiences to share thoughts and opinions with others. Should others’ upbringing and experiences with money work for your specific situation? Probably not. Let’s slow down and make sure you have a customized approach that meets your goals and, most importantly, your expectations.
Recently, I worked with a client who was certain that Company XYZ was a sure thing. The company had great leadership in place, a history of strong performance, and no foreseeable issues on the horizon. This feeling or situation is a well-known behavioral bias called Representativeness. A good company is also a good investment, right? Turns out that within a couple of months of our conversation, there was a systemic change that significantly impacted the future of the industry, and not only did Company XYZ take a tumble, but so did many others within the industry. Was Company XYZ ever a bad company? No. At the time, was anything known on the horizon that would signal an industry shift? No. Seemingly out of left field, the landscape shifted, and a good company was no longer a good investment. My client was very thankful we discussed this common bias and determined a more suitable plan. This is just one example to illustrate how behavioral bias may cloud our judgment in a given moment, which can put you in a precarious position as an investor.
Diversification and Education at Merriman
At Merriman, we help clients establish a diversified portfolio to ensure their eggs are never just in one basket. Next time you debate getting rid of the old shirt you haven’t worn in years or think about why you made that one financial decision in the face of opposing statistics, recognize that behavioral biases may play a more significant role in your decision-making than you think. Merriman advisors take pride in educating clients, and future clients, of the many different approaches to financial planning and work to identify what impacts each unique situation. Sometimes, it’s our behavior. If it would be helpful to talk with one of our advisors, please reach out, as a conversation may be exactly what you are looking for.
Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable; however, Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal, or accounting advice, and nothing contained in these materials should be taken as such.
The Accredited Behavioral Finance ProfessionalTM or ABFPTM program, is a program designed for mid-career and advanced career financial professionals that enhances advisors’ emotional competencies, client interactions, and financial planning advice through a thorough understanding of psychological explanations for economic behavior and hands-on practice of knowledge. The ABFPTM program brings together comprehensive research and trends from leaders and experts in the area of behavioral finance with engaging activities.
To qualify, candidates must complete online coursework and take a final exam within 120 days of beginning the program. Topics include behavioral finance theory and implications, emotions in investors & financial markets, behavioral investing, risk detection and debasing, investor bias mitigation and neurofinance, and new frontiers in behavioral finance. The final exam consists of 65 questions covering all modules, and candidates have a lifetime maximum of two attempts to pass. Accredited Behavioral Finance Professionals are required to complete 16 hours of continuing education credits every two years.
From the College for Financial Planning®
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Mike came to Merriman after several years spent in corporate finance and brought with him an innate sense of discipline. Whether surfacing through routine, structure, or a desire for predictability, discipline often guides his decision making. He enjoys helping clients determine goals and create a plan to achieve them. He sincerely believes you can accomplish all you set out to with the right structure and discipline.
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